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If commissions to buy and sell ETFs sound like bad news to you, it might be exciting to know that hundreds of exchange-traded products are eligible for commission-free trading across a number of different platforms. Schwab and Vanguard both offer their lineups of ETFs free in brokerage accounts for their clients, which can help to lower the total expenses that come with maintaining an ETF portfolio.
Though some investors are hesitant to use ETNs because of the aforementioned credit risk component, there are instances in which these products can deliver significant advantages over other structuresoften the case as ETNs can deliver cheaper, more efficient access to natural resources. The lack of tracking errors means that the slippage associated with rolling futures contracts is avoided, while the lack of a portfolio avoids brokerage commissions.
Part of the appeal of ETFs (and mutual funds) is the ability to immediately achieve diversified exposure to a basket of securities; it is far easier to purchase a single ETF than dozens or hundreds of stocks found within that fund. But when it comes to diversification, not all ETFs are created equal. Assuming that a potential ETF investment diversifies away any security-specific risk by holding a balanced portfolio could be a costly mistake.
The good news is that there are a number of other ETF options for protecting your portfolio against inflation, ranging from precious metals to short-term bonds to more sophisticated inflation-focused ETFs.
One of the more impressive innovations in the ETF industry in recent years has been the development of index-based products that mimic strategies employed by hedge funds. From broad-based ETFs such as QAI to more targeted funds such as CSMA and MCRO, hedge fund ETFs have the potential to be extremely useful diversifying agents within traditional stock-and-bond portfolios.
In addition to offering access to a wide range of asset classes, ETFs have become increasingly effective tools for segmenting popular indexes. In particular, low volatility ETFs have seen a surge in popularity in recent years as tools for smoothing out the ups and downs of a portfolio by focusing on the individual stocks that tend to experience the smallest fluctuations in value.
For investors who want to include some exposure to our neighbors to the north in their portfolios, there are a handful of ETFs that specifically target Canadian stocks. EWC focuses on large Canadian stocks (with a tilt towards financials) while CNDA targets smaller companies.
Included in the lineup of ETFs is a growing number of long/short products that delivers market neutral exposure to investors. These ETPs essentially implement spread trading techniques, allowing investors to capture the difference in returns between two asset classes (which can be very similar or very different). There are a few potentially appealing attributes of long/short ETFs. First, these products are capable of delivering gains in any environment since they focus only on relative returns. Second, the market neutral portfolios maintained results in very low volatility, which can bring valuable diversification benefits to a long-term portfolio.
Investors should note that there are some potential biases in RAFI weighting; the focus on dividends as one of the key metrics can result in a value tilt, while the focus on revenue can skew portfolios towards low margin or high debt companies.
In a similar vein, Direxion now offers a suite of volatility response ETFs that adjust allocations to a target asset class (such as large cap U.S. stocks) depending on recently observed volatility in the underlying securities. When volatility is low these ETFs can go up to 150% long, effectively amplifying the exposure achieved. When volatility spikes, the allocation drops considerably to the risky asset (with proceeds put into cash). These ETFs can be intriguing alternatives to asset classes that are often core holdings in long-term portfolios, allowing for a cheap way to implement what could otherwise be a very time consuming and costly rebalancing. Here are a few examples of volatility response ETFs:
AGG and BND are by far the two most popular ETFs in the Total Bond Market ETFdb Category. Their inclusion there, however, might be a bit misleading, since these funds really only offer exposure to a narrow segment of the global bond market. Many investors use AGG and BND (or similar products) as the bulk or entirety of their fixed income portfolios, which certainly keeps things simple. But that also delivers a very limited portfolio that overlooks other key segments of the global bond market entirely.
Most investors looking to generate alpha spend the bulk of their time seeking out asset classes that are positioned to outperform. But in many cases, alpha can just as easily be derived by what your portfolio excludes; steering clear of troubled asset classes can be an efficient way to beat the markets. This is especially true from a sector perspective, as there are often significant gaps between the various segments of the global economy.
Quite simply, investors should never judge an ETF by its cover. For most funds, the name gives almost all of the relevant details. But in some cases, titles can be deceiving. There are countless examples in the ETF lineup. Many small cap ETFs have big allocations to mid caps. The SPDR S&P Middle East & Africa ETF (GAF) has about 90% of its portfolio in one country. The list could go on and on. Take advantage of the transparency of ETFs before investing, and make sure the portfolio is consistent with your objectives.
When it comes to commodity investing, many investors commit the sin of energy bias, whereby the majority of their commodity holdings fall under the umbrella of an asset like crude oil or natural gas. To be fair, energy products are among the most popular in the commodity world, but exhibiting a bias towards these investments can have some adverse effects on your portfolio. Energy products are quite often highly correlated to the movement of general markets, meaning that they will move closely in line with something like the S&P 500. One of the main reasons that commodity exposure is essential to a portfolio is the low correlation and diversification benefits that these investments offer. An energy-heavy portfolio will likely only steepen your losses on bad days which may not be enough to be erased by days in the black.
Energy investments are obviously very important; the majority of these commodities offer relatively inelastic demand because we cannot survive without them in our daily lives. But with these futures and products being particularly volatile, committing a bias may only hurt you in the long run. Instead, it is important to remember to keep vital energy holdings in check with other commodities like precious metals or softs. This way, a portfolio will still reap all of the benefits offered from energy, but will also gain the diversity of commodities tied to vastly different price drivers that offer sometimes zero correlation to major benchmarks.
Now, there are a wealth of other options that aim to erase or avoid contango altogether; one of the most intriguing products is the United States Commodity Index Fund (USCI). This fund marks the third generation of commodity products, as it employs a unique strategy that was the first of its kind. Each month, the fund chooses 14 futures contracts from a basket of 27, creating a unique portfolio with automated commodity diversity. For those looking to play the commodity space through an exchange-traded structure, this may be one of the most compelling long-term strategies.
Emerging market investing has become a staple for any long-term portfolio, as the growth that these economies can potentially offer has been far too enticing for most investors to pass up. As these respective nations begin to develop and expand, there is one inevitable trend that will emerge: infrastructure. With soaring populations, increased urbanization, and rapidly developing economies, a solid infrastructure is a must.
There are a couple ETFs out there that invest in stocks of publicly-traded private equity firms and business development companies, which in turn generally hold portfolios full of privately held entities. These investments can take various forms, including traditional equity, preferred stock, or various types of debt. The PowerShares Private Equity Portfolio (PSP) and Business Development Company ETN (BDCS) are two such products that might be worth a closer look by many investors.
When considering these products, be sure to review the underlying index methodology. A pair of copper ETFs highlights the issue that can potentially arise. COPX focuses on mining stocks that are engaged primarily in copper mining. CU, on the other hand, casts a much wider net that includes diversified mining companies (with an adjustment to weighting based on the percentage of operations focused on copper). The former therefore has a copper-focused portfolio, while the latter includes a number of stocks with operations focusing on other metals.
ETFs can be useful tools year round, but may become particularly helpful at the end of the year when investors begin to consider ways to reduce tax liabilities. ETFs can be handy tools for harvesting tax losses without dramatically changing the composition or risk/return profile of a portfolio. In other words, investors can sell off a losing fund and reallocate the proceeds to a product with a similar, but slightly different objective.
Exposure to emerging markets has become an increasingly important aspect of long-term portfolios in recent years, as these economies have established themselves as the most meaningful sources of GDP growth. Many investors have elected to achieve exposure to emerging markets through ETFs, a logical choice given the numerous advantages of the exchange-traded structure. Broad-based products such as EEM and VWO are a nice start to a balanced emerging markets allocation, but further tuning is required to achieve a truly well-rounded portfolio. And there are ETFs that can help: 59ce067264
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